The Irrelevance of Comparative Advantage

Those advocating protectionist policies are often met with the stock response of ‘you don’t understand the principle of Comparative Advantage’. But it seems to me that economists haven’t put much thought into it themselves, as Comparative Advantage does not necessarily support free trade, particularly in developing countries. In fact, if you accept the ‘infant industry’ argument, it turns out Comparative Advantage has very little to say for developing countries or industry – it is irrelevant.

Perhaps a statement of Comparative Advantage is due. The idea is that every country should produce what it is most efficient at producing, regardless of what other countries produce – that is, each country should allocate its time as efficiently as possible based on its own strengths, resulting in maximum overall production. Trade barriers create extra costs and therefore inefficiency, which is undesirable.

Furthermore, a brief qualification of the ‘infant industry’ argument: as tariffs direct business to new industries by making them comparatively cheaper, they can develop brand loyalty, benefit from economies of scale and lower costs, gain expertise, establish contacts and trust with suppliers and distributors, and benefit from long term investments due to higher short term profits.

The problem is this: if by producing something, an industry can improve its long term ability to carry on producing it, Comparative Advantage becomes irrelevant in the short term. As with much of neoclassical economics, it is a static snapshot and does not capture dynamics like this. For example, if country A produces coke at 100 gallons a year and milk at 150 gallons a year, while country B produces coke at 50 gallons a year and milk at 25 gallons a year, Comparative Advantage is clear – A should produce milk and B should produce coke, even though A has an absolute advantage in both. This results in the highest net production possible.

However, what if country A’s coke industry and country B’s milk industry are new industries? And by producing milk, B can eventually up its milk yields to 200 gallons a year, whilst A could up its coke production to the same? Suddenly Comparative Advantage has nothing to say, and protecting these industries from competition as they develop seems like a good idea in the long run, both for individual countries and for net production as a whole.

The fact is that, as well as being compatible with one of neoclassical economist’s pet theories, extensive evidence supports the protectionism for development idea. Comparative advantage also has numerous other flaws in its applicability to free trade (one of which, the mobility of capital, was actually noted by Ricardo himself). Overall, it is not clear why it retains its status as some sort of irrefutable truth of the benefits of free trade, given that it actually has little to say about what trade policy should or shouldn’t be.

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  1. #1 by Guillermo on December 10, 2011 - 1:09 pm

    Some years ago I learned of comparative advantage from Mankiw’s book (so this is also a relevant issue in light of the Harvard walkout). The presentation was the standard Ricardo 2×2 table with 2 countries producing 2 commodities. This model seems like one of the silliest in all of introductory economics. First, I don’t remember any justification being presented for the claim that comparative advantage, rather than absolute advantage, should dominate in international trade (would it hold between 2 regions within a country for example?). Presumably some sort of model which implies this can be constructed by making other assumptions about the behavior of exchange rates, immobility/mobility of capital and labor etc. but I don’t remember them being explained. In any case, countries do not trade with each other outside of centrally planned economies – trade takes place between independent firms in the context of a monetary economy whereas that table makes it look as if entire countries “barter” goods with each other directly.
    Check out Anwar Shaikh’s work on this topicif you haven’t already:

    http://homepage.newschool.edu/~AShaikh/

    • #2 by Unlearningecon on December 10, 2011 - 1:22 pm

      Yes I have also been confused by how CA takes a country as a unit when the rest of neoclassical economics is based around individuals maximising their utility.

      If one were feeling slightly harsh, you could dismiss CA as a fairly worthless thought experiment that captures almost no real-world dynamics, much like the Parable of the Broken Window or Laffer Curve.

      Thanks for that link, looks interesting.

  2. #3 by Mandos on December 10, 2011 - 10:30 pm

    Excellent. Keep ‘em coming.

    Make any of these obvious points and you are immediately accused of committing “long-exploded fallacies”. Refer to the actual realities out there, and fingers are stuck in ears…

  3. #4 by Wheylous on January 18, 2012 - 7:53 pm

    How do we judge when we need to apply tariffs?

    • #5 by Unlearningecon on January 18, 2012 - 11:59 pm

      Big question, but mostly on the grounds of whether a country has sufficiently developed industries or not, which would be based on its BoP/growth.

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